The "Danger Years" for Homeowners, Current Financing Methods Making Things Worse

Here's a piece from Money that was new news to me: that the "danger years" (years where home loan delinquencies peak) are actually the third and fourth years of a mortgage. I always thought it was the first two years, but here's what Money has to say:

Although borrowers are often told that the first year is the hardest, delinquencies have historically reached their highest points during the third and fourth years of mortgages, according to Doug Duncan, chief economist for the Mortgage Bankers Association (MBA).

And with the recent home-buying binge, many homeowners are approaching these years:

The number of Americans affected by the coming danger years could be huge. Half of all mortgage loans are three years old or less, according to the MBA. Nearly $3 trillion in mortgages originated in 2002, $4 trillion in 2003 and $3 trillion again in 2004. Many were refis, but there were also record totals of new purchases as well.

Here's what causes problems in years three and four:

"As a mortgage ages, things can go wrong," he says.

There are a few forces at play: After years of strained budgets, borrowers may have little in savings to draw on to handle a crisis; this is also the period when major repairs begin to crop up; finally, many home buyers go through life changes, including starting a family.

In addition, many of these transactions involved risky loans, such as interest-only ARMs and no-down payment loans.

A recent report from the National Association of Realtors found that the median new home buyer put down just 2 percent in 2005. Forty-three percent put down no money at all. And according to SMR Research, some 25 percent of loans were interest-only, do nothing to reduce the debt on the house.

"Lenders used to offer interest-only loans to only the best credit-quality prospects. That's no longer true," said Stuart Feldstein, founder of SMR Research.

I've talked until I'm blue in the keyboard about the dangers of interest-only and no-down-payment mortgages. It looks like many of those who took out these loans could soon be facing some hard times. Which is just my point -- people borrow everything they can to get the biggest house possible, then they get into deep financial trouble when an unexpected expense pops up -- which it always does.

My alternative? Follow a reasonable formula for buying a house.

Comments

[Dus10]

Out of the entire homeownership "racket," I think Realtors are the most beneficial to homeowners. For instance, my Realtor often makes recommendations to me about my home, even though I am not in the pipeline to sell for several years. However, even Realtors seem to be pushing the agenda to get people to move into bigger homes. And why not? It is in their best interest to have people moving around; that is how they make their money. So, you usually have mortgage lenders/brokers in cahoots with a builder, and then you may find your self with a bad choice in a Realtor. Instead of pushing the trend of moving every seven years, perhaps people should be looking to hold onto their properties longer. I would say that ten years is a good number (although, I probably won't be following that advice, myself).

Why? It gives you some comfort years. For instance, if you think you could make the move after seven years of owning a home, why not wait three more? Surely, you will be in a much better position. You will have lived a life where you were more than comfortable with making your payments, you will have built up more home equity, and you may even be saving more funds and making more improvements to your home.

[Anonymous]

One real estate investor I know has sold a lot of his properties recently. There isn't a very big bubble here, but prices have hit what he and I think is a peak just because of rising interest rates. He's holding cash. I have no idea how much. I'm sure he's going to pick up some bargains over the next couple of years. He doesn't have to buy foreclosed properties. A lot of those on the market will drive down the price on anything else getting sold.

Another point that is worth considering is that the numbers published for average home sale prices often aren't worth the paper they're printed on. They are certainly real, but they lump together too many variables. The reasons that people sell are different. Some people can afford to hold onto their homes until the market rebounds, even if it takes a couple of years. Other people get bit when they have to move for one reason or another and have to sell quickly.

Adding to that is that developers don't build evenly across an entire area. They'll put up a subdivision or two at a time. They'll do it where they can get a good location for a price they like. Generally, those houses are going to be larger than the average older home in the immediate area, newer, and with many of the latest "features". They will drive up the average price for the town. That doesn't mean your house 2 miles away on the other side of town is worth any more than it was the day they broke ground for the first house in the development.

[Sherlock Phones]

I've known for a number of years that many homeowners are going to end up in trouble as a result of using risky loan packages to purchase more home than they can reasonably afford. Once the fixed term portion of their variable rate ends, their mortgage payments will jump significantly and probably continue to climb for some time. It's a sad situation, and therefore there are two things I need to do. First warn people not to use these loans (and only purchase what they can truly afford). Second, find a way to profit from those who don't heed the warning.

Does anyone have any ideas on how to profit from this situation? Obviously I could try to acquire property at foreclosure auctions but (despite what you might have heard) they generally sell at or near market rate. Sometimes, when inexperienced bidders get caught in a bidding war, they sell for more than market rate. There are also those who teach to buy the properties while distressed but before they go into foreclosure. Competition is stiff, and you're dealing with people in a very unhappy place in their lives.

I was looking for something a little less hands-on. Perhaps investing in a good public company that provides foreclosure services. Any ideas?

~Rod

[Dus10]

Rod: Those are good points, and are probably indicative of why the "danger years" are 3 and 4, rather than 1 or 2, because borrowers tend to go with the 2-1 Buy down or something of that nature.

As far as profiting off of those who don't take the warning... you can purchase the home before they actually get foreclosed on. The lender is usually willing to sell the property for less than is owed because they would lose even more in the costs of foreclosing and holding the property. Heck, we can not hardly get a foreclosed property in my area, because they bank holds the property for about a year before they will allow it to be sold. This process would be called a short sell. The homeowners will benefit because they will not get a foreclosure on their credit (and they likely have little to no equity in the house). The bank gets a benefit because it will not have to hold the property and follow through with the foreclosure process. And you win because you are getting a property ready to move in (in most cases) at a discount (and the homeowners will not likely trash the property, because you are helping them... and there would be definate legal consequences because you go through a traditional sale/closing process).

[financial reflections]

This is sad for many homeowners, but it's an opportunity for those hoping to invest in real estate. I'm not about to lose my home, but I am facing a refinancing decision right now...